Muni bonds: Fall from grace?

The municipal bond market entered the month of August on a roll. A seemingly disproportionate level amount of…

The municipal bond market entered the month of August on a roll. A seemingly disproportionate level amount of demand over supply of available new issues had, in my opinion, driven the market higher for many weeks, producing positive returns for virtually all categories. Year-to-date returns for the Barclays Municipal Bond Index* was 5.31% as of July 31. However, there was concern from investors that nominal rates were again pushing toward all-time lows which were achieved in February 2012, from which emerged a five week adjustment. The past two weeks have seen a growth in new issue supply, and, ignoring the two $10bn note deals (one from California, the other Texas), the municipal bond market slipped a little, perhaps under the spell of summer vacations and modest supply, to post higher yields for familiar and attractive names.

The good news, in my opinion, is that municipal bonds have not fallen from grace, and with yields currently at slightly higher levels than around this time last month, investors may re-emerge from their summer somnolence to find a healthy marketplace offering strong relative value (versus other asset classes) with strong evidence of interest. For week ending August 22, there was over $400mm of inflows into municipal bond funds according to Bond Buyer.

Investors want to know what to do next. The Fed continues to assert that rates will remain low for some time to come. Under that forecast, I remain constructive on municipal bonds as an asset class. As unemployment rates subside, and states’ tax collections continue to grow (for the 9th consecutive month), these conditions could set the foundation for a strengthening economy. Bumps in the road can and do occur, of course, and if there were no risk, I believe there would be zero yield. All things considered, I believe there is potentially reasonable compensation in the muni asset class.

James Colby is the senior municipal strategist, fixed income, responsible for Van Eck Global’s municipal bond investments. This commentary originally appeared on his blog.